You could have an incredible idea for a new product, technology or business, but without capital, it will never be more than just an idea. Unless you have access to a pile of money that you have been saving for a rainy day, you have two options: You can attempt to bootstrap your growth or you can raise capital.
I’m a huge fan of bootstrapping, and it can be a viable option if you are extremely cautious when it comes to expenses, if you have a little seed money and if your business concept will generate cash flow early.
If bootstrapping isn’t a good fit, then you need startup capital, which can be secured from several sources. While every funding option has pros and cons, there are certain mistakes you need to make sure you avoid when seeking startup capital, like the five outlined below.
1. Underestimating how much money you need
A lot of entrepreneurs think they will stand a much better chance of securing funding if they ask for a smaller amount, but this approach will crush you one of two ways. First, most investors will see that you have underestimated what it will take to be successful and walk away.
Even if you do secure funding, though, you will eventually run out of money if you requested less than you needed. When you know how much money you need to start your business, you stand a better chance of receiving the capital needed and surviving. Most startups fail, so you need to do everything possible to help increase your chance of survival.
2. Giving up too much equity in the beginning
Investors often want an attractive equity stake in exchange for their startup money, but giving up too much equity in the beginning can be disastrous.
In a perfect world, you would raise enough money in the first investment round to become profitable, eliminating the need to ever have to raise money again. Unfortunately, startups face many unforeseen challenges and obstacles along the way, and you can't count on the best possible outcome.
That's why it’s important not to dilute yourself too early. If you have to raise more money down the road, your ownership stake can shrink to virtually nothing. No entrepreneur starts this grueling journey with the goal of being a minority owner in his or her own company.
3. Getting buried in personal credit card debt
Many startup founders use personal credit cards to fund their business, which is one of the most expensive funding options if you have less than stellar credit. Your credit scores typically dictate the annual percentage rate your card issuers give you. Studies have shown that businesses that heavily rely on credit card financing will typically fail.
Racking up personal credit card debt puts you in a very bad position, especially if the business fails. If you have to close the business, you are still left with a mountain of debt on your shoulders that has to be paid back. If you fall behind on payments, your credit score will be destroyed, negatively impacting your personal finances.
Every entrepreneur thinks his or her idea is a winner, and while confidence is great, don’t let it cloud your judgment, especially when it can potentially ruin your personal finances. I hate the thought of racking up credit card debt to start a business just as much as Mark Cuban, who says, “Credit cards are the worst investment . . . unless you pay them off every 30 days. Even then, don’t do it.”
4. Falling for advance fee loans promising funding regardless of credit history
With so many individuals seeking funding to start a business, it should be no surprise that there are criminals trying to take advantage of these entrepreneurial desires. Advance fee loan scams guarantee funding no matter how bad your personal credit history is.
They ask for an upfront fee -- often saying it’s for processing -- and once you pay the fee, the loan never happens. It’s easy to say, “I’d never fall for that,” but the fact that the Federal Trade Commission (FTC) has a page dedicated to warning consumers about this scam proves it’s a major problem.
If you come across one of these advance fee scams, you can report it to the Better Business Bureau’s Scam Tracker here.
5. Not having a detailed cash-flow analysis
Anyone who is about to write a check, whether it’s a VC firm or traditional lending institution, is going to want to see that you have a full grip on the cash-flow and more importantly, how you plan on spending their money.
You have to account for every penny that comes in and leaves because most business decisions revolve around cash flow. Poor understanding of your own cash flow can lead to having no available cash for day-to-day operations, which will eventually cause your business to collapse.
Developing a cash-flow analysis shows potential investors you have a firm grip on the operational side of the business. Also, a cash-flow analysis is very hard to fake, letting you know just how great your great idea can be.